Despite Fed Big Cut... "Bank of Korea Expected to Cut 0.25%P in October"

US Federal Funds Rate Slashed by 0.5 Percentage Points
High Possibility of South Korea Lowering Base Rate Next Month
Speed of Rate Cut Likely to Be Adjusted Considering Household Debt and Others

Choi Sang-mok (right), Deputy Prime Minister and Minister of Economy and Finance, and Lee Chang-yong, Governor of the Bank of Korea, are attending the 'Macroeconomic Financial Meeting' held on the 19th at the Seoul Regional Public Procurement Service Annex in Seocho-gu, Seoul, exchanging opinions. Photo by Kang Jin-hyung aymsdream@

The U.S. Federal Reserve (Fed) has implemented a 'big cut' by lowering the benchmark interest rate by 0.5 percentage points, bolstering expectations for a rate cut by the Bank of Korea (BOK) within this year. The market largely anticipates that the BOK will only reduce the benchmark rate by 0.25 percentage points next month, from the current 3.5% to 3.25%. This reflects expectations of a moderated pace considering the rising household debt and the inverted interest rate situation in the U.S.

Possibility of South Korean Rate Cut Increases Following U.S. Big Cut

On the 18th (local time), the Fed lowered the upper bound of its target range for the benchmark interest rate from 5.50% to 5.0%, a 0.5 percentage point cut, at the Federal Open Market Committee (FOMC) regular meeting. This is the first U.S. rate cut since March 2020.

On the morning of the 19th, the BOK held a market situation review meeting regarding the U.S. rate cut and noted that Fed Chair Jerome Powell's cautious stance on the pace of future rate cuts during his press conference was somewhat hawkish in the international financial markets.

During the press conference, when asked about the pace of future rate cuts, Powell said, "We make decisions at each meeting based on incoming data, economic outlook developments, and the balance of risks (inflation and employment)," adding, "If deemed appropriate, we may proceed more slowly." Following Powell's remarks, U.S. Treasury yields rose, stock prices fell, and the U.S. dollar remained steady.

The BOK assessed that the U.S. rate cut would provide some leeway in future monetary policy operations. BOK Deputy Governor Yoo Sang-dae stated at the meeting, "The pivot in U.S. monetary policy is beginning, which is expected to positively affect the reduction of volatility in the foreign exchange market," emphasizing, "This increases the capacity to focus monetary policy on domestic economic conditions, inflation, and financial stability going forward."

The Fed's big cut is expected to further raise market expectations for a rate cut by the BOK in October. Political circles have been pressuring the BOK to lower rates due to sluggish domestic demand caused by high interest rates and inflation, and such voices may grow louder.

The rapid stabilization of inflation also increases the likelihood of a BOK rate cut. Last month, the consumer price inflation rate was 2.0%, aligning with the BOK's inflation stabilization target. This is the lowest figure in three years and five months since March 2021 (1.9%). With international oil prices stabilizing, inflation in September is also likely to remain near 2%. BOK Governor Lee Chang-yong stated earlier this month, "From the perspective of inflation stabilization, it is now a time when a rate cut can be sufficiently considered."

Joo Won, head of economic research at Hyundai Research Institute, said, "With the U.S. implementing a big cut, the possibility of a BOK rate cut next month has increased," adding, "Considering the sluggish domestic economy, stabilizing inflation, and the trend of rate cuts in major countries, the BOK can no longer delay lowering the benchmark rate."

Household Debt Is the Biggest Variable for Rate Cuts

However, the rapidly increasing household debt remains the biggest variable for a rate cut. The rise in household debt means that the BOK's second policy goal, 'financial stability,' is not being met. According to the BOK, bank mortgage loans increased by 8.2 trillion won compared to the previous month last month, the largest increase since related statistics began in 2004. Bank mortgage loans have been rising for 17 consecutive months since March last year.

Including mortgage loans and other loans (such as credit loans and commercial real estate secured loans), bank household loans increased by 9.3 trillion won compared to the previous month in August. This is the largest increase in three years and one month since July 2021.

Governor Lee stated right after the rate freeze last month, "The BOK's monetary policy is aimed at financial stability, and the key factors for financial stability are real estate prices and household debt," adding, "The BOK must not make the mistake of rapidly lowering interest rates or excessively supplying liquidity, which could stimulate real estate price inflation expectations."

If the upward trend in household debt does not subside, it is expected that the BOK may slow down the pace and timing of rate cuts. Jo Young-moo, a research fellow at LG Economic Research Institute, explained, "Although the Fed's big cut has increased the possibility of a BOK rate cut in October, the high level of household debt remains the biggest variable," adding, "If the rate is cut in October, it will likely be limited to a 0.25 percentage point reduction." However, Jo added, "Since strong household debt suppression measures by the government and banks are currently being implemented, the increase in household debt is expected to slow down."